Unemployment

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Unemployment

The full employment of
labour has been a key
economic objective ever since the mass
unemployment experienced in the 1930s. When employment levels are less
than their maximum possible an economy is experiencing unemployment. If
labour is employed, but not effectively used, the situation is called
underemployment.

The costs of
unemployment

Opportunity cost

Unemployment represents an opportunity cost
because there is a loss of output that workers could have produced
had they been employed. The
government is also forced to spend more on unemployment benefit. The money going on unemployment benefit
could be spent on hospitals or schools.

Waste of resources

Resources not employed are left idle, and this
is a waste to an economy – education and training costs are wasted
when individuals who have received these benefits do not work.

The Chancellor loses revenue

The unemployed do not pay income tax, and pay
less indirect tax as they spend less.

Erosion of human capital

Many skills are acquired at work, and being
unemployed means can mean fewer new skills are acquired, and
existing skills are lost.

Lower incomes

The unemployed have lower personal incomes and lower
standards of living. In addition, the unemployed also suffer
relatively poor physical and mental health.

Externalities

There are further external costs associated
with unemployment, such as increased crime, alcoholism and
vandalism.

Hysterisis

When unemployment exists it can become embedded in
the economy. For example, even those made temporarily unemployed,
because, perhaps, their employer goes out of business, may find it
difficult to get back into the labour market. The longer they remain
unemployed, the harder it becomes to gain work. This may be because
workers lose skills, or because they lose the habit of working. Over time,
some workers may become
permanently excluded from employment and join the ranks of the long
term unemployed (unemployed over 1 year) with little prospects of work.

Measuring unemployment

Measuring unemployment accurately is
made difficult because of imperfect knowledge. Not all instances
of unemployment are recorded, and records of unemployment may
be inaccurate. Because the unemployed are eligible for benefits, some
may claim benefit even when they work.
Conversely, many of the unemployed may not bother to inform the authorities, and
therefore unemployment goes unrecorded.

Claimant count and ILO unemployment

The Claimant Count

The Claimant
Count records those claiming unemployment benefit (Job Seekers Allowance,
or JSA) and can prove they are actively looking for
work. It excludes housewives and those on training schemes.

How useful is the Claimant Count?

The Claimant Count may not reflect the true level of
unemployment in the UK economy, given that not all the unemployed will
bother to claim, and some are deterred because they cannot prove they
are looking for work. This is especially true of part-time employees
who are much less likely to register as unemployed compared to
full-time workers. While some individuals may fraudulently claim, it is
generally recognised that the Claimant Count under-estimates actual
unemployment levels.

The International Labour Organisation (ILO)

The labour force survey is undertaken by the International Labour Organisation
(ILO) and is a more direct assessment of unemployment, rather than those
who claim benefit. It is
based on an interview of a sample of 60,000 households (approximately
100,000 people) and tries to measure unemployment as a whole, rather
than those simply claiming benefits. To be considered as being
unemployed individuals must:

To be regarded as being unemployed, individuals must:

Have been out of work for 4 weeks

Be able to start work in the following 2 weeks –
they must be readily available for work

Be available for work for one hour per week.
Therefore, part-time unemployment is included in the measurement although
part-time workers are
unlikely to claim unemployment benefit. This tends to make ILO
unemployment rather higher than the Claimant Count.

For example, according to the ONS, ILO unemployment in 2009 was
2.46 million, whereas the Claimant Count was just 1.64 million.

How useful is the ILO survey?

Since 2003 it has become the government’s official
measure of unemployment, although it can be argued that it over-estimates true
unemployment by including people only looking for a few hours part-time
work. As a sample, it can be subject to sampling error, which reduced
its accuracy.

UK unemployment

European unemployment

Unemployment in Europe relatively high compared with the USA, Japan
and the UK.

Types of unemployment

There are several types of unemployment,
each one defined in terms of cause and severity. Recognised types of
unemployment include the following:

Cyclical

Cyclical
unemployment exists when individuals lose their jobs as a result
of a downturn in aggregate demand (AD).
If the decline in aggregate demand is persistent, and the
unemployment long-term, it is called either
demand deficient,
general, or Keynesian
unemployment. For example, unemployment levels of 3 million were reached
in the UK in the last two recessions, between 1980 and 1982, and between
1990 and 1992. In the most recent recession of 2008-2010, unemployment levels
rose to 2.4m in the last quarter of 2009, and reached a 17 year
high of 2.6m by late 2011. By
2016
unemployment had fallen to 1.68m.

Demand deficient unemployment

This is caused by a lack of aggregate demand, with insufficient demand
to generate full employment.

Structural unemployment

Structural unemployment occurs when certain
industries decline because of long term changes in market
conditions. For example, over the last 20 years UK motor vehicle
production has declined while car production in the Far East has
increased, creating structurally unemployed car workers.
Globalisation
is an increasingly significant cause of structural unemployment
in many countries.

Regional unemployment

When structural unemployment affects local areas of
an economy, it is called regional unemployment. For example,
unemployed coal miners in South Wales and ship workers in the North East
add to regional unemployment in these areas.

Classical unemployment

Classical unemployment is caused when wages are
‘too’ high. This explanation of unemployment dominated
economic theory before the 1930s, when workers themselves were blamed
for not accepting lower wages, or for asking for too high wages.
Classical unemployment is also called real wage unemployment.

Seasonal unemployment

Seasonal
unemployment exists because certain industries only produce or
distribute their products at certain times of the year. Industries where
seasonal unemployment is common include farming, tourism, and
construction.

Frictional unemployment

Frictional
unemployment, also called ‘search’ unemployment, occurs when workers
lose their current job and are in the process of finding another one.
There may be little that can be done to reduce this type of
unemployment, other than provide better information to reduce the
search time. This suggests that full employment is impossible at any
one time because some
workers will always be in the process of changing jobs.

Voluntary unemployment

Voluntary unemployment is defined as a
situation when workers choose not to work at the current equilibrium
wage rate. For one reason or another, workers may elect not to
participate in the labour market. There are several reasons for the existence of voluntary
unemployment including excessively generous welfare benefits and high rates
of income tax. Voluntary unemployment is likely to occur when the equilibrium wage rate is below the wage
necessary to encourage individuals to supply their labour.

Structural change

Over the last
30 years, employment in the service sector has increased to over 70% of
total employment, while employment in manufacturing has decreased to
under 20%. Since the 1940s, employment in the primary sector, including
agriculture, has been less that 3% of the workforce.

Recent changes have created two-speed economy, with a booming service
sector and a declining manufacturing one.

The main
reasons are:

Globalisation
and the rise of new ‘low cost’ overseas competitor countries.

Structural unemployment and labour mobility

Labour immobility is likely to increase structural unemployment.
Although the expanding industries are growing and need labour, they are
not necessarily able to employ the same workers who have been displaced
in the declining industries.

There are three types
of labour immobility:

Geographical immobility

Geographical immobility occurs when workers are not
willing or able to move from region to region, or town to town.
Geographical mobility is
made worse by immense
house price variation between regions. It may be extremely difficult for
workers in Yorkshire to sell their home and buy an equivalent one in
London.

Other factors also contribute to geographical
immobility, such as strong social and family ties, and parents being
unwilling to disrupt their children’s education by changing schools. The
stresses of moving home can also be a deterrent to mobility
for some.

Industrial immobility

Industrial immobility occurs when workers do
not move between industries, such as moving from employment in
the motor industry to employment in the insurance industry. Industrial
immobility has affected the UK, and many other industrial countries, as
the growth of service industries, and the decline of manufacturing
industries, has increased the need for mobility.

Occupational immobility

Occupational immobility occurs when workers find it
difficult to change jobs within an industry. For example, it
may be very difficult for a doctor to retrain to be a dentist.

Industrial and occupation immobility are most likely to happen when
skills are not transferable between industry and job.

Information failure also contributes to labour immobility
because
workers may be immobile because they do not know where all the suitable
jobs for them are.

A
resulting problem with labour market immobility is that it can create
regional unemployment, which is a type of
structural unemployment.
This means that a change in the structure of industry leaves some people
unable to respond by changing job, industry, or location and as a result,
they
remain temporarily or permanently unemployed.

Immobility can also lead to rising labour costs, as firms have to
increase wages to encourage workers to re-locate.

Labour market or government failure?

New
Classical economists would tend to see structural unemployment as an example of
government failure. Labour markets do not clear, they argue, because
wages are not allowed to adjust effectively, and the price mechanism is
distorted. By removing distortions and imperfections in the labour
market, workers would move more quickly from job to job.

For example,
by keeping welfare benefits to a minimum there is an incentive to
retrain and look for paid work. Welfare benefits can trap individuals
into a life of unemployment because of the effects of
moral hazard and
the disincentive effect it creates. This increases labour
immobility,
and hence contributes to structural unemployment.

However,
labour immobility can also be addressed from the perspective of labour
market failure. Training and re-training are regarded as
merit
goods, where individuals under perceive the long term benefit to
themselves. They also fail to appreciate the positive externalities that
training and re-training generate for the wider community. This means
that there is a significant role for the state in providing free or
subsidised training and retraining programmes.

In addition,
there is the potential situation of labour market poaching. Why should a firm in the booming
service sector provide free training to a displaced worker from the
manufacturing sector if the worker will leave for another job shortly
after training? Why should firms do any training at
all if they believe that workers will be poached by higher
wages? The poacher can, of course, afford to pay higher wages because of savings in
training costs.

The natural rate of unemployment

This is a term associated with
New Classical and
monetarist economists. It is defined as the rate of unemployment that
still exists when the labour market it in equilibrium, and includes
seasonal, frictional and voluntary unemployment. The concept was used by
the US economist
Milton Friedman to help explain the connection between
unemployment and inflation, as demonstrated by the
Phillips Curve. Friedman argued that
if unemployment falls below the natural rate there will be an
increase in the rate of inflation.

NAIRU and sustainable employment

The Non-Accelerating-Inflation Rate of
Unemployment (NAIRU) is a similar concept to the NRU. Short-run
NAIRU is the short run level of unemployment where inflation is neither
likely to rise or fall. Long-run NAIRU is defined as the rate of
unemployment at which inflation stabilises once any short run shocks
have worked their way out the macro-economy. Long-run NAIRU is usually
assumed to be the level of unemployment that exists when the economy is
operating on its long run Phillips Curve.
The implication is that a level of unemployment below NAIRU is
unsustainable for an economy. It is clear that NAIRU is a significant
policy concept which has
helped shape modern macroeconomic policy.

In the 1980s it was generally thought that NAIRU in
the UK was around 7%. However, according to most economists, a
combination of factors, including effective supply-side policy and the general
increase in ‘rational expectations’ on the part of employers, workers
and trade unions has reduced NAIRU to around 5%.

Insider-outsider theory – some workers are
permanently excluded from participating in labour markets.

Efficiency wage theory

This
New Keynesian interpretation of NAIRU suggests
that information failure is common in the labour market –
information is asymmetric and employers do not know how productive workers are
until after they have employed them.

Good workers have a higher reservation wage, which
is the minimum wage at which workers are prepared to
work.

Firms need to set their wage above equilibrium to
ensure a supply of good workers because low pay will only attract
inferior workers (See:
The Lemon’s problem).
In this case, higher wages are efficient
because they enable the best workers to be employed, but, this leaves
some unemployed, even at equilibrium.